The financial incentive to default loans, and examples
Analysis of IRS 990 filings of federal student loan guarantors proves without doubt that the income derived through this fee system is vast, as evidenced by not only the income of the guaranty agencies, but also by the salaries, bonuses, and perks taken by the executives who run them. This fee system is, indeed, the lifeblood of these organizations, who derive about 60% (on average) of their income through this legalized wealth extraction mechanism. Clearly, it is in the guarantors financial interest that students default on their loans. In fact, were there no student loan defaults, the guarantors would barely exist.
Additionally, it is often in the financial interest of the lenders that students default. Large lenders derive income from not only lending and servicing operations, but also from collection assets (and even guarantor assets in the case of Sallie Mae) owned or controlled by the company. This leads to the common situation where a loan is defaulted by a lender, becomes vastly inflated with unverified and unchecked collection costs, and then becomes a revenue stream for the guarantor and collection company...all potentially owned (or controlled) by the very same lender! A defaulted loan clearly can produce far more revenue for the system. It is obvious that this structure gives the lender/guarantor/ collector entities a perverse incentive to default loans rather than providing customer service aimed at helping the borrower avoid default.
Indeed, Sallie Mae's own annual reports provide compelling evidence of dramatic profiteering from defaulted loans: In the 2003 annual report, The Sallie Mae CEO brags to shareholders in the opening remarks that the company's record earnings that year were attributable to collections on defaulted loans. The company's "fee income" increased by 228% between 2000-2005, while their managed loan portfolio grew by only 87% during the same time period.
It is a matter of record that lenders actually defaulted student loans without even attempting to collect on the debt! In 2000, Sallie Mae paid $3.4 million in fines as a result of the U.S. Attorney's office discovering that the company was invoicing for defaulted loans where the borrower was never contacted. Rather, records were fabricated to indicate that the borrower had been contacted. Similar cases were settled with Corus bank and Cybernetic Systems.
There is also some evidence that suggest this tendency to default borrowers is by design rather than a mere result of circumstance. In 2007, an employee of the Kentucky Higher Education Assistance Authority, KHEAA, contacted StudentLoanJustice.Org by email, and submitted that the agency managers had purposely marketed loans to poor, disadvantaged communities in the expectation that these citizens would default on their loans, thus be "on the hook" for the fees and penalties that would result-extractable through garnishment of the income sources mentioned previously. This raises serious concerns, as it clearly implicates KHEAA in engaging in predatory lending. The text of these communications was forwarded to the Department of Education, and it is unknown what, if anything, resulted).
Obviously, collection companies prefer that loans default. Guarantors clearly share this preference. That lenders and collection companies also share this financial motivation is sufficient, to characterize the lending system as predatory, since the lending system clearly has both motive and means to act in such a way as to encourage default, rather than being motivated to act in a way that avoids default.
An unbiased observer should rightly object here, and point out that there is governmental oversight that should prevent this sort of activity. After all, at the end of the day, these defaults must certainly be a drain on the taxpayer...right?
Wrong. It was reported in January 2004 by John Hechinger (WSJ) that for every dollar paid out in default claims, the Department of Education would recover every dollar in principal, plus almost 20% in interest and fees. Further, supplemental materials in the president's 2010 budget show a recovery rate for defaulted FFELP loans of about 122 %. This is the amount recovered compared to the amount of the loan at the time of default. Compare this recovery rate to that for defaulted credit cards, which is usually about 25 cents on the dollar, and one can see that defaulted loans are clearly not costing the Department of Education money. In fact, simple, comparative analysis shows clearly that the reverse is indeed the case. In other words: The Department of Education is making more money on defaulted loans than loans which remain in good stead.
Therefore, all entities involved: The lenders, the guarantors, the collection companies, and even the Department of Education and its agents have a financial incentive for student loans to default...and this all is a direct result of the lack of consumer protections and the draconian collection powers that exists uniquely for federal student loans as described above.
http://studentloanjustice.org/argument.htm
Post a comment